Key Takeaways
- Interest-only repayments hold the deductible balance steady and free up cash each month, at a rate premium of roughly 0.2 to 0.4 percentage points.
- Lenders assess an existing interest-only loan on principal and interest over the term left after the interest-only period, which quietly reduces what you can borrow next.
- On an illustrative $600,000 loan, the repayment steps up by around 20% the month the interest-only period ends.
- The right structure follows your tax position, your cash flow and your next purchase, not a generic list of pros and cons.
Every investment loan application asks the same question, and most guides answer it as a preference between lower repayments now and a smaller debt sooner. Interest only vs principal and interest is priced in three places at once, and only one of them shows up on the loan offer.
The rate is the one printed on the offer, and the tax treatment is straightforward to model. The third sits inside the next lender’s calculator, and for anyone planning a second or third property, it usually decides the outcome.
With the cash rate held at 4.35% since 11 August 2026 after three increases earlier in the year, the monthly gap between the two structures is real money, and the wrong structure can cost more than a slightly higher rate ever does. Comparing the two on repayment structure rather than headline rate is where the better outcomes sit, and it is the first question an investment property loan broker works through.
What Each Repayment Type Does to the Balance
Under principal and interest, every repayment covers the month’s interest and a slice of the balance, so the debt falls from the first payment across the full term, usually 30 years.
Under interest only, you pay the interest and nothing else for a set period, commonly five years and up to 10 in total with some lenders. The balance does not move. At the end of that period, the loan reverts to principal and interest over whatever term remains.
Interest only also costs more per dollar borrowed. Most lenders price it around 0.2 to 0.4 percentage points above the equivalent principal and interest rate on investment lending. Part of that is a legacy of the Australian Prudential Regulation Authority (APRA) capping interest-only lending at 30% of new residential mortgage lending in 2017, a limit removed at the start of 2019, which pushed lenders to price the two products apart, and the gap never fully closed. The rest is risk logic. A loan sitting at its full balance for five years carries more exposure than one being repaid.
One $600,000 Loan Under Both Structures
Take an investor borrowing $600,000 over 30 years, choosing between principal and interest at an illustrative 6.9% and a five-year interest-only period at 7.2%. Figures below are rounded and illustrative, differing by lender and over time. The choice shows up in five places:
Monthly Repayment Set by Each Structure
Interest only produces a repayment of $3,600 a month, which is simply the interest bill. Principal and interest produces around $3,950. The gap is roughly $350 a month, about $4,200 a year, per property. Across three properties, an interest-only structure can free up more than $12,000 a year, most often redirected into an offset account or the deposit fund for the next purchase.
Balance Left After Five Years
Principal and interest reduces the loan to around $564,000 over the same five years, roughly $36,000 of debt retired. The interest-only balance is still $600,000. That $36,000 is equity you own outright rather than equity the market gave you, and it is the part that does not disappear when values soften.
Deduction Preserved by an Unchanged Balance
Because the interest-only balance holds at $600,000, the full interest bill stays deductible through the interest-only period, assuming the borrowing was used for investment purposes. Under principal and interest, the deductible debt shrinks each year, so the deduction shrinks with it. This matters most where you still owe money on your own home, since paying principal off the investment loan means retiring the tax-effective debt first while the non-deductible debt sits untouched. Many investors instead run interest only on the investment loan and park the difference in an offset against the home loan. Deductibility follows the purpose of the borrowing, so the detail belongs with your accountant.
Capacity Assessed for Your Next Purchase
Lenders do not assess your existing interest-only loan at the $3,600 you actually pay. APRA confirmed on 28 May 2026 that the serviceability buffer remains at three percentage points, and the loan is tested on principal and interest over the term left once the interest-only period ends. Five years used leaves 25, not 30. Assessed at around 10.2% over 25 years, the interest-only loan models at roughly $5,540 a month. The principal and interest loan, assessed at around 9.9% over its full 30 years, models at roughly $5,220. The interest-only structure adds around $320 a month to your assessed commitments, which on this illustration costs somewhere near $35,000 of borrowing capacity for the next property. Stack that across several interest-only loans and a structure chosen for cash flow can close the door on the purchase it was meant to fund.
Total Interest Paid Across the Term
Run both to the end and the interest-only route costs more. On these illustrative rates, principal and interest over 30 years produces around $823,000 of interest, while five years of interest only followed by 25 years of principal and interest produces around $911,000. The difference is the premium plus five years of interest charged on a balance that never fell.
What Happens When the Interest-Only Period Ends
The interest-only period ends on a date, not by degrees. Six ways that ending plays out:
Facing the Reversion in Year Six
In year six, the $600,000 has to be repaid across 25 years instead of 30, at the same rate. The repayment moves from $3,600 to around $4,320, an increase of roughly 20% in one month. Where the interest-only period ran 10 years, the remaining term is 20 and the step is sharper again.
Absorbing the Higher Repayment
Taking the new repayment suits investors whose rent and income have grown across the five years and who built the reversion into the plan. It is also the only one of these that requires nothing from a lender, which matters where your income or expenses have moved in the wrong direction since the loan was written.
Extending the Interest-Only Period
Lenders will consider an extension, and the request is a fresh credit decision rather than an administrative one. Your income, expenses and equity are reassessed under current policy, and an extension shortens the remaining principal and interest term further. A borrower who passed comfortably five years ago may not pass now.
Refinancing the Loan to a Fresh Term
Moving the loan can reset a full 30-year term, which lowers the monthly repayment and stretches the debt out longer. Where the property has grown in value, the lower Loan to Value Ratio (LVR) makes the refinance easier, and that same growth can be released as equity to fund the next deposit in the one transaction. Refinancing is also a full assessment, so it is worth testing 12 months out rather than in the final month.
Switching the Structure Before Expiry
Moving to principal and interest before the period expires is usually straightforward, and it converts one large step into a smaller one taken on your timing. Where the reversion would land in the same year as a tenancy ending, bringing it forward separates the two events.
Selling the Property Before the Reversion
Selling removes the reversion, and the timing rarely lines up neatly. Under section 104-10 of the Income Tax Assessment Act 1997, the capital gains tax event happens on the contract date and not at settlement, so a sale signed in June falls into that financial year. Break costs apply where the loan is still inside a fixed term, and the proceeds have to clear the whole balance, since none of it has been repaid. Where a sale is the plan, listing well before the reversion date avoids selling under the pressure of a repayment you did not budget for.
Which Repayment Structure Suits Which Investor
Neither option is the safe one. The useful question is which constraint binds you first.
Interest only tends to suit investors who:
- Still carry non-deductible debt on their own home and want the surplus flowing into an offset against it.
- Are funding a renovation, a construction period or a season of variable income.
- Have surplus borrowing power, so the tighter assessment does not block the next purchase.
- Hold a clear plan for the end of the interest-only period rather than an intention to deal with it later.
Principal and interest tends to suit investors who:
- Carry no non-deductible home debt, where the tax argument largely falls away.
- Want maximum capacity for the next property, since the longer assessed term and lower rate both help.
- Prefer forced debt reduction and the lower lifetime interest bill that comes with it.
- Are close to the debt-to-income ceiling, where a smaller balance over time is worth more than monthly cash flow.
Lender Policies That Decide the Answer
Structure is only half the decision. Which lender writes it changes the price and the consequences:
Premium Charged for Interest-Only Repayments
The gap between interest-only and principal and interest pricing is set lender by lender. On a $600,000 loan, 0.2 percentage points is around $1,200 a year and 0.4 is around $2,400, so the premium alone can outweigh a headline rate difference between two lenders.
Maximum Interest-Only Term Allowed on Investment Lending
Most lenders offer one to five years on investment lending, some allow up to 10 in total and a few restrict the term further above certain LVRs. Extensions count towards that total, so a five-year term already extended once may leave no further room.
Stated Reason Required for an Interest-Only Term
Lenders ask why you want interest only and record the answer, because the National Consumer Credit Protection Act 2009 requires reasonable inquiries into a borrower’s requirements and objectives before credit is approved. A stated purpose that matches the structure, such as clearing non-deductible home debt first or carrying a property through a renovation, reads differently to no reason at all. Where the answer does not support the request, the application may simply be written as principal and interest.
Policy Applied to Debts Held Elsewhere
Lenders differ on how they assess loans you hold with other institutions, and a minority take a more generous view than they do of their own. For an investor carrying several interest-only loans, that single policy difference can move the result more than the rate on the new loan.
Quota Set for High Debt-to-Income Lending
Since 1 February 2026, APRA has limited banks and other authorised deposit-taking institutions to writing no more than 20% of new lending at a debt-to-income ratio of six times or higher, measured quarterly and applied separately to owner-occupied and investment portfolios. Interest only does not lower your debt-to-income ratio, since the ratio counts the balance rather than the repayment, so holding the balance flat keeps you closer to the ceiling for longer. Where a lender has filled its quota, timing matters as much as position, and your borrowing capacity may sit outside your control that quarter.
Maximum LVR Permitted on Interest-Only Lending
Several lenders cap interest-only investment lending below the LVR they would allow on principal and interest, commonly around 80%, and some decline interest only above that line entirely. Choosing interest only can therefore raise the deposit required for the same property.
Lender pricing, maximum terms and assessment policies referred to here are current at the time of writing, differ between credit teams and may change without notice.
Loan Structure That Survives Your Next Purchase
The repayment figure is the one part of this decision that stops mattering within five years. Picking on repayment size alone is how investors end up with a structure that funded this year and blocked next year.
Priced properly, including the reversion date and the way the next lender will read the loan, the answer follows from your own position and rarely matches anyone else’s.
Where you are weighing up which repayment structure to use on your investment loan, the team at DIY Lending can talk you through the options that suit your circumstances.
Frequently Asked Questions (FAQs)
1. Can I make extra repayments on an interest-only loan?
Most variable interest-only loans allow additional repayments, though paying down the balance reduces the deductible debt, which is usually the reason the structure was chosen. Anything extra also stays paid, since redrawing it later can change the deductible purpose of the amount you take back out.
Fixed interest-only loans commonly cap additional repayments and may charge a break cost, so the loan documents decide this, not the general rule.
2. Does an offset account work on an interest-only loan?
Yes with most lenders, and the interest saving reduces the repayment directly, since the repayment is the interest bill. Funds in the offset stay available, which is what makes it the usual home for the cash flow an interest-only structure frees up.
A small number of lenders restrict offset accounts on interest-only investment products or charge a package fee for them, so it is worth confirming before the structure is set.
3. Will the lender tell me before my interest-only period ends?
Most send a notice in the months before, though the obligation and the timing vary by lender. The reversion happens on the scheduled date regardless of whether the notice was read or received.
Diarising the expiry from the day of settlement is more reliable, and it leaves room to refinance or restructure in the 12 months before the reversion date.
4. Can I run interest only on some loans and principal and interest on others?
Yes, and portfolio investors commonly do, holding interest only on investment debt while paying down a home loan. Each loan is priced and termed on its own, so the premium applies only to the loans actually carrying interest only.
The next lender still assesses every loan together, so a mixed portfolio is read on its combined assessed repayments. Staggering the expiry dates across loans also keeps two or three repayment steps from landing in the same year.
5. Is a fixed rate available on an interest-only period?
Commonly yes, and the fixed term and the interest-only term do not have to match, which is where problems start. A fixed rate expiring in year three of a five-year interest-only period creates two separate repayment changes, and break costs apply if you restructure inside the fixed term.
Lining the two terms up, or deliberately staggering them, is a decision worth making at application, not one to discover later.
6. What happens to my interest-only loan if I move into the property?
Deductibility follows use, so interest relating to any period the property is used privately is not deductible, even where the loan arrangement is unchanged. The lender may need to reprice the loan from investment to owner-occupied terms.
Telling the lender is a condition of most loan contracts. Doing it before you move in keeps the change a repricing question instead of a breach of your loan terms.
This article is general information only. It does not take your objectives, financial situation or needs into account, and it is not a recommendation to act. Interest rates, lender pricing, maximum interest-only terms and assessment policies referred to are illustrative or current at the time of writing and may change without notice. You may wish to speak with a qualified professional, such as a licensed credit representative or a registered tax agent, before acting on anything set out here.